Advance Pricing Agreement in India Practical Insights

Transcription

1 APA, SAFE HARBOUR & MAP Advance Pricing Agreement in India Practical Insights 1. Background Since the Transfer Pricing Regulations were introduced in India in April 2001, Transfer Pricing ( TP ) has emerged as a key tax challenge for multinational enterprises doing business in India. The nature of TP controversies range from selection of comparable companies to complex issues like intragroup services, financial transactions, transactions relating to use or transfer of intellectual property ( IP ), business restructuring, etc. TP controversies along with the amount of adjustment has grown manifold. This is evident from the below chart which depicts the quantum of adjustment along with number of cases over the years. 1 л лµ ö Ó ² ß¹ Number of adjustment cases Amount of adjustment (in INR billion) TP being factual in nature and applied differently in different countries (based on the economic and business scenario of that country), has become a subject ö Ð ²» ô ²» ² ±² Ì ²¼ Ì ² º» Ð ½ ²¹ô ÛÇ Ó ² ¹» ô ²» ² ±² Ì ²¼ Ì ² º» Ð ½ ²¹ô ÛÇ øß»¼ ¾ Õ» «Ó» øì» ª»»»»¼ ²» ½»» «±» ±² ª» ò ² ²±» ±«¼ ¾» ²»»»¼ ± ¾» ª» ±º «±»³ ±» ± ² ±º» ±² ± ¹ ² ±² ½ «±» ±½»¼ò Ú ô ³ ¾» ²±»¼ ß ½» ½±² ² ²º± ³ ±² ² «³³ º± ³ ²¼»»º±» ²»²¼»¼ º± ¹»²» ¹«¼ ²½» ±² ò ²± ²»²¼»¼ ± ¾» ³» ô»º»»²½» ±«¼ ¾» ³ ¼» ±» ±» ¼ª ± ò ÈÈÈ ìï ÙÔÑÞßÔ ÌßÈßÌ ÑÒ ÊÑÔò ï ÖËÔÇ îðïê íðç

2 of international tax controversies throughout the world. In view of this, there arose a need to have a mechanism to provide certainty so as to avoid such litigation. Advance Pricing Agreement ( APAs ) are binding agreements entered into in advance between taxpayers and tax administrations on the transfer pricing methodology to be adopted for the covered transactions for a specified period of time. APAs have been successfully employed globally by taxpayers to resolve TP disputes, seek greater certainty in tax treatment, optimise administrative and monetary costs and gain freedom from onerous documentation rules and penalty risks. 2. Introduction of APA The Government of India ( GOI ) in its Union Budget 2012 introduced APA regime in India with an intent of reducing litigation and as its one of the key investor-friendly tax initiatives. The GOI on realising the severity of the rising TP litigation and quantum of adjustments made by the tax authorities on account of TP issues came out with the alternative mechanism of APA process. In July 2014, Rollback provisions in APA were also introduced to provide certainty on the pricing of international transactions of 4 years (rollback years) preceding the first year from which APA becomes applicable. The APA regime in India therefore, has provided a promising opportunity to find a mutually beneficial solution to TP issues for both taxpayers and tax authorities, which have eventually brought some stability and consistency in the Indian TP landscape. With notification of Rollback rules in March 2015, the taxpayer has been provided the option to choose certainty in transfer pricing matters with the Government for a total of nine years (5 future years and 4 prior years). With the signing of 64 APAs as on 19 April , everyone s eyes are now set on the delivery of further positive results that this Indian tax policy will make in this coming decade. General APA process It is optional (anonymous permitted) Pre-filing international transaction, pricing mechanism It involves filing of Form 3CED providing APA main application It involves: Negotiation and conclusion of APA It involves: Execution and monitoring íïð ÙÔÑÞßÔ ÌßÈßÌ ÑÒ ÊÑÔò ï ÖËÔÇ îðïê ÈÈÈ ìî

3 3. Practical experience with the APA team Ever since the launch of the APA program, there has been an enthusiastic response from taxpayers as the overall experience with APA ptogram has been admirable. The uncertain and unpredictable domestic tax law litigation process makes the APA program an attractive option for managing TP controversy in advance. Some of the following points summarize what went well with the APA program: enthusiastic, cooperative, responsive, and importantly nonintrusive or non-investigative in their approach; adversarial and solution/resolution oriented. team have been performed with an open mind with no prejudices the business of the taxpayer through site visit process to resolve past open tax years cases faster like cost plus cases (support services, IT enabled services, Business Support Services, etc) position of the government on several issues in relation to APA filings, process, application etc. 4. APA statistics so far 3 With 146 application in the first year (including 29 application for Bilateral APAs), the APA application has reached to 711 application (including 80 application for Bilateral APAs) by March The typical transactions on which APAs have been filed include share valuation, corporate guarantee, trading business, shipping support, advisory support, IT/ITES services, marketing services, contract manufacturing activity, royalty payment, intra group charges. Below diagram would demonstrate the total APA applications with break up of bilateral applications filed in each year. Ç» ï ÚÇ îðïîóïí Ç» î ÚÇ îðïíóïì Ç» í ÚÇ îðïìóïë Ç» ì ÚÇ îðïëóïê ̱ ïìê Ú»¼ îíî Ú»¼ îðí Ú»¼ ïíð Ú»¼ éïï Ú»¼ îç îê ïë ïð èð The government, through the Central Bureau of Direct Taxes (CBDT), had signed a record 64 APAs with multinationals out of which 3 are bilateral APAs as on 19 April Unilateral APA The APA outcomes have been quite reasonable for taxpayers facing adjustment during TP audits. With respect to unilateral APAs, cost plus models have been accepted in case of the taxpayers engaged in providing business support services, marketing support services, IT enabled services, contract manufacturing activity, etc. The range of mark up on the cost for rendering such services is from 12% to 22%. These results are much better than the markups applied by the Revenue authorities during the transfer pricing audits and the margin proposed by Safe Harbour rules prescribed by the GOI. 4.2 Bilateral APA The 80 Bilateral APA applications are with countries like USA, UK, Japan, Australia, Sweden, Switzerland, Denmark. Out of 80 applications, 3 bilateral APAs were signed with Japan in December 2014 and two with UK in Company. It is also been said that the discussions between Competent authority of India and Japan were fast tracked due to the visit of Indian Prime Minister to Japan. transaction of management charges and brand ÈÈÈ ìí ÙÔÑÞßÔ ÌßÈßÌ ÑÒ ÊÑÔò ï ÖËÔÇ îðïê íïï

4 royalty for two UK based companies engaged in manufcaturing of automotive and industrial component. 5. Practical Insights/ Experience - Illustrative Some of practical insights/experience on certain issues are provided below: 5.1 Absence of Article 9(2) in the OECD model convention India is of the view that in the absence of a correlative adjustment clause in a tax treaty [equivalent of Article 9(2) of the OECD Model Convention], India would not entertain a Bilateral APA. This approach has denied opportunity for a bilateral APA in case of some of India s large trading partners such as France, Germany, Singapore and Korea. It has been reported that India will renegotiate its tax treaties with such countries or relook its position on not entering into bilateral APAs in the absence of correlative relief clause in the relevant tax treaty, to pave the way for bilateral APAs with those countries. 5.2 Automatic Exchange of information Pursuant of Base Erosion Profit Shifting ( BEPS ) environment, APA authorities are inserting a new clause of auto exchange of information of APA with the government of Associated Enterprise ( AEs ) countries in the APA. This is a step towards increasing transparency which is one of the objective towards BEPS program. As per master file reporting requirements recommended by OECD s Base Erosion and Profit Shifting Project, each multinational enterprise (MNE) group has to give list and details of the unilateral APA entered into by the group. Accordingly, the tax authorities would be able to see the complete picture about the transfer pricing policy and pricing adopted by the MNE group in different countries for same transaction. Therefore, MNE groups need to ensure that, the transfer pricing policy adopted in their unilateral APAs is aligned globally. It is important to note that, India has also adopted master-file reporting requirements in Budget Hence, the Indian APA authorities may examine the other unilateral APAs reported in masterfile for similar transactions for which APA application is made in order to ensure consistency in pricing methodology/policy. 5.3 Out of book adjustment The common question which taxpayer ask is whether it is necessary to bring money to the extent of difference of book value and arm s length price determined by APA in India? Presently, APA officials in some cases insist the actual receipts to flow back in India. In countries like South Africa, etc, secondary adjustments are allowed which means if the difference of book value and arm s length is not brought back to the relevant country, it would be either considered as dividend paid or loan provided to AE. India does not have any provisions regarding secondary adjustments. However, on case to case basis (such as JV situations), India APA officials may allow out of book adjustments by increasing the mark up to factor the Deemed Dividend Distribution Tax that India may have to lose if cash is not brought in India. 5.4 Risk adjustment In theory, the assumption of increased risk is normally compensated by an increase in the expected return. Controlled and uncontrolled transactions are comparable only when adjustments with respect to significant differences between them in risks assumed is made. The APA authorities tend to evaluate such adjustment on a case-to-case basis. 5.5 Working Capital Adjustment Working capital adjustment is essentially an adjustment for the opportunity cost of making investments in working capital (i.e., inventories, accounts receivable/ debtors and accounts payable/creditors) which require capital and operating assets. At arm s length, an uncontrolled entity will expect to earn a market rate of return on that capital, independent of its operations. However, the amount of capital required varies greatly, because the level of inventories, debtors and creditors measured as a percentage of the total cost varies. There is an effect on profits from investing in different levels of working capital due to differences reflected in cash collection cycle. Working capital adjustment analysis seeks to adjust the profitability of each comparable company based on the working capital position of the taxpayer to reflect the differences in working capital investment. With respect to APA experience, usually, APA authorities consider a credit period of days as reasonable. It is observed that APA authorities tend íïî ÙÔÑÞßÔ ÌßÈßÌ ÑÒ ÊÑÔò ï ÖËÔÇ îðïê ÈÈÈ ìì

5 to examine such adjustment claim made by taxpayers on case to case basis. The taxpayers are required to demonstrate the need of such adjustments on the basis of the facts and merits of their case. 5.6 Acceptance of foreign tested party/ complex TP methodologies The overall attitude of APA authorities has been non-adversarial and solution/resolution oriented. There has been a sincere attempt by the APA officials to understand the business of the taxpayer by undertaking the site visits to taxpayers business premises which has resulted the APA officials to appreciate and consider complex TP methodologies / positions. These includes selection of overseas entity as the tested party, use of Berry ratio for companies not engaged in routing purchase and sale through P&L but into buy-sell procurement model, yield curve method/interest saving approach for corporate guarantee, variable royalty, etc 6. Conclusion The APA regime in India has been one of the most positive developments and has been a display of the government s attempt to create a positive outlook in the minds of the existing taxpayers and has also created a conducive environment for multinationals and foreign investment players. It is a promising opportunity to find a mutually beneficial solution for various transfer pricing issues and will help in bringing stability and consistency in the Indian TP landscape. Thus, overall, introduction of APA program is a step in the right direction. The APA office has been actively moving the inventory of cases by preparing position papers in several cases, expeditiously and proactively discussing outstanding issues with taxpayers. The increasing number of APA applications demonstrates the success of the APA programme in India. 1. Source: Annual reports issued by Ministry of Finance 2. Source: Economic times 19 April Media reports 4. Source: ÈÈÈ ìë ÙÔÑÞßÔ ÌßÈßÌ ÑÒ ÊÑÔò ï ÖËÔÇ îðïê íïí